Audited Financial Statements

A financial audit, or more accurately, an audit of financial statements, is the review of the financial statements of a company or any other legal entity (including governments), resulting in the publication of an independent opinion on whether or not those financial statements are relevant, accurate, complete, and fairly presented. Financial audits are typically performed by CPA firms of practicing accountants due to the specialist financial reporting knowledge they require. The financial audit is one of many assurance or attestation functions provided by CPA firms, whereby the CPA firm provides an independent opinion on published information. Many organizations separately employ or hire internal auditors, who do not attest to financial reports but focus mainly on the internal controls of the organization. External auditors may choose to place limited reliance on the work of internal auditors.

Purpose

Financial audits exist to add credibility to the implied assertion by an organization’s management that its financial statements fairly represent the organization’s position and performance to the firm’s stakeholders (interested parties). The principal stakeholders of a company are typically its shareholders, but other partiessuch as tax authorities, banks, regulators, suppliers, customers and employees may also have an interest in ensuring that the financial statements are accurate.

The audit is designed to reduce the possibility that a material misstatement is not detected by audit procedures. A misstatement is defined as false or missing information, whether caused by fraud (including deliberate misstatement) or error. “Material” is very broadly defined as being large enough or important enough to cause stakeholders to alter their decisions.

Audits exist because they add value through easing the cost of information asymmetry, not because they are required by law. For example, a privately-held company that does not issue securities on a public exchange might engage a firm to audit its financial statements in order to obtain more desirable loan terms from a financial institution or trade accounts with its customers. Without the audit, the lending party would not have assurance as to whether or not the company’s financial position is accurate. In turn, the lender could price protect against this information asymmetry.

The exact form and content of the “audit opinion” will vary between countries, firms and audited organizations.

In the US, the CPA firm provides written assurance that financial reports are “fairly presented in conformity with generally accepted accounting principles GAAP.” The measure for “fairly presented” is that there is less than 5% chance (5% audit risk) that the financial statements are “materially misstated.”